Avoiding red flags: How to lower your plan's audit risk
Are only the largest retirement plans audited? The truth is that plans of any size can be audited by the IRS and the DOL. Your plan could be selected for a random audit, or as a result of IRS datasets that target certain types of plans. However, lots of audits are triggered by specific events. Learning to avoid the red flags can help reduce your risk and increase the odds that you will survive any audit for which you are selected without major problems.
Your Form 5500 can be audit bait
Bad answers to Form 5500 can attract the Labor Department’s attention and serve as audit bait. The best way to make sure that your Form 5500 filing doesn’t lead to an audit is to check it carefully — with outside assistance if necessary — to make sure that the compliance questions are answered correctly.
For example, one compliance question asks whether the plan is protected by an ERISA bond and if so, the amount of coverage. Never answer “no” to this question. If for some reason you didn’t have a bond before, get one now. It is even possible to obtain retroactive coverage.
A coverage amount that is too low is also a red flag. In most cases, the bond must be for at least 10% of plan assets at the beginning of the year, although plans with certain types of investments must have higher coverage. Since assets at prior year end and at the beginning of the year are also shown on the 5500, showing an amount lower than 10% of those assets will invite the DOL to follow up.
The DOL will also look at the investment and financial information shown in the asset report. If your plan has many alternative investments such as hedge funds, has invested in other hard-to-value investments, or if you have large amounts of un-invested cash, you may also be inviting a follow up by the DOL. If your asset values as of the end of the prior year do not match your opening year balance for the succeeding year, you are also inviting unwanted inquiries.
Other answers that may get you targeted for further investigation are: if you indicate that you have late deposits of employee contributions or that you have not made required minimum distributions to former employees who are 70.5 years old. Note that this question does not need to be answered “Yes” if reasonable efforts have been made to find the participants but they still can’t be located.
Don’t ignore employee claims and complaints
Many plan sponsors don’t realize that employee complaints to the IRS and DOL often lead to audits. Make sure that employee questions and complaints receive a response, and if a formal claim for benefits is filed, make sure to follow the ERISA regulations on benefit claims and appeals. It is a good idea to run any denials past your ERISA attorney to make sure they are consistent with the written plan terms and clearly explain the participant’s appeal rights and the reason for the denial.
If your plan is selected for IRS or DOL audit, expect to be asked to provide executed plan documents, participant notices and fiduciary policies, such as your Investment Policy Statement. Keep these in a file to avoid a last-minute scramble to satisfy the auditor’s requests. You should also be prepared to show that you are making diligent efforts to find missing participants, deal with defaulted loans and review plan fees, which are current hot issues for auditors.
To be even better prepared, you can do a self-audit to identify problems that need correction before the IRS or DOL do.